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On 1 April 2014, the President of the Republic of Chile, Michelle Bachellet, presented a comprehensive tax reform to the Chilean National Congress. The proposed tax reform aimed, primarily, to

  1. increase tax revenues in a context of growing social expenditure,
  2. reach a more equitable tax burden distribution between Chilean individuals and corporations,
  3. incentivise long-term investments and savings and
  4. tackle tax avoidance by means of international tax planning.


The most important tax reform proposals included the following items:

  • Gradual increase of Chilean corporate income tax
  • Introduction of alternative mechanisms of shareholder-level income taxation: “attribution” vs “cash” basis
  • Deductibility of interest and related-party payments
  • Reform and new guidance on thin-capitalisation rules
  • Introduction of Controlled foreign corporation (“CFC”) and General anti-tax-avoidance (“GAAR”) rules

The initial tax reform proposal was further amended by a Protocol of Agreement approved by the Chilean Senate on 15 July 2014 and several amendments brought forward by the Chilean Government in August 2014.

The final tax reform law, N° 20.781, was published in the Official Chilean Gazette on 29 September 2014.[1]


New article 41 G of the Chilean Income Tax law

One of the most significant tax changes introduced by law N° 20.781 is article 41 G which brings in CFC provisions into the Chilean tax framework through the update of the Chilean Income tax law. [2]

Scope of application

New article 41 G of the Chilean Income tax law establishes that any taxpayer or “patrimonio de afectacion” – which is domiciled, resident, constituted or established in Chile – controlling directly or indirectly foreign entities (i.e. not domiciled or resident in Chile), will have to include in its income tax basis any “passive income” earned or accrued at the level of the foreign controlled entities (“CFC entity”).

In concrete terms, the new CFC rules will apply to the following:

  • Natural persons with domicile or residence in Chile
  • Legal entities constituted in Chile
  • Natural persons with no domicile or residence in Chile and legal entities constituted outside of Chile that establish themselves in Chile as per section 58(1) of the Chilean Income tax law
  • “Patrimonios de afectacion” constituted or established in Chile, for instance, mutual or investment funds
  • Administrators or holders of third party rights which are subject to tax and are domiciled, resident, constituted or established in Chile, through which foreign entities (i.e. no domicile or residence in Chile), are managed and controlled.

Definition of CFC entities under Chilean tax rules

New article 41 G, letter A, defines CFC entities as non-resident and non-domiciled entities [3] which are constituted, domiciled, established, formalised or resident in a foreign jurisdiction and fulfil the following criteria:

On the year-end closing date or, at any time during the twelve preceding months:

  • The controlling person (i.e. natural or legal) Chilean resident holds (hereinafter, the “Controlling person”), on its own, directly or indirectly, 50% or more of the (i) capital (ii) profit rights or (iii) voting rights of the CFC entity
  • The Controlling person holds, together with related parties (natural persons or legal entities as defined in section 100 of the Chilean Securities Market law Nº18.045)[4] – resident, domiciliated, constituted or established in Chile or abroad – directly or indirectly, 50% or more of the (i) capital (ii) profit rights or (iii) voting rights of the CFC entity
  • The Controlling person has been empowered to – on its own or in conjunction with related parties – (a) nominate, change and revoke the majority of the directors or administrators of the CFC entity (b) amend unilaterally the articles of association of the CFC entity

In addition to the above, there is a rebuttable legal presumption (i.e. accepts proof to the contrary) under which it is assumed that CFC entities will exist as well if

  1. the foreign entity is constituted, domiciled or resident in a nil or low-taxed jurisdiction [5],

  2. the Controlling person holds, directly or indirectly, an option to purchase 50% or more of the shares or rights (i.e. capital, profits rights, and voting rights) of the foreign entity.


Definition of “passive income”

Based on the new section 41, Letter G of the Chilean Income tax law, the following types of income are, amongst others, to be considered as “passive income” [6]:

  • Dividends and any other type of profit-sharing instruments related to held shareholdings;
  • Interest income and other revenues covered in section 20, Letter 2 (i.e other types of financial income) of the Chilean Income tax law [7]
  • Royalties (brands, patents, formulas, IT software…)
  • Capital gains realised upon disposal of rights or goods
  • Rental income or capital gains generated by the disposal of real estate properties, except where the latter have been realised in the context of a commercial activity
  • Income derived from the assignment to a third party of the right to use any of the goods or assets which generate “passive income” as defined in the Chilean Income tax law
  • In addition, section 41 G establishes a rebuttable legal presumption under which all the income earned or accrued by the CFC entity is considered as “passive income” if the latter is constituted, established, domiciled or resident in a low or nil tax jurisdiction or territory [8]


Miscellaneous

Should the CFC entity be held by multiple Controlling persons, the passive income will be allocated to each Chilean resident shareholder, based on the participation held by each of them in the CFC entity.

The Controlling persons will be entitled to deduct in Chile the foreign taxes paid on the “passive income” so that double taxation on the same revenue is avoided.

The Controlling persons will have to maintain an updated and detailed registry including the (i) “passive income” to be imputed on an annual basis, (ii) dividends distributed by foreign entities, (iii) taxes effectively paid with respect to the type of revenues previously mentioned (iv) any other information to be further detailed by the Chilean Tax Authority through the issuance of Administrative resolutions.

Timing

The new CFC rules will apply to any “passive income” earned or accrued by CFC entities as from 1 January 2016[9].

Please do not hesitate to contact Gonzalo Garcia Perez or your usual Lombard International Assurance representative if you have any queries or require further information.


References:

[1]  Ley N° 20.780 de 29 de Septiembre de 2014, reformando la Ley sobre Impuesto a la Renta, contenida en el artículo 1° del Decreto Ley N°824 de 1974

[2]  Ley sobre el Impuesto a la Renta contenida en el artículo 1° del decreto Ley N°824 de 1974

[3]  The definition of “entity” covers any type of company, community of assets, public or private investment fund, patrimonio de afectacion, trust fund or any other foreign investment vehicle irrespectively of its legal form.

[4]  For instance, (i) entities belonging to the same group as the Controlling person, (ii) parent companies and subsidiaries of the Controlling person, (iii) any person empowered to nominate, on its own or in conjunction with other persons, one member of the Board of the Controlling person or (iv) any person controlling, at least, 10% of the capital of the Controlling person.

[5]  Please refer to Circular Nº12 – on section 41, letter H of the Chilean Income tax law –  issued by the Chilean Tax Authority in 2015

[6] CFC rules will only apply if the “passive income” realised at the level of the CFC entity exceeds 10% of the total income realised by the CFC entity in one accounting year. Should the “passive income” exceed 80% of the total income realised by the CFC entity in one accounting year, all the income realised by the CFC entity will be deemed as “passive income” as per Chilean tax rules.

[7]  Foreign entities (i) exercising a regulated financial or banking activity, or (ii) constituted, domiciled, established or resident in a jurisdiction or territory covered in article 41(D) N°2 and 41 (H)

[8] For additional information please refer to article 41 – letter H of the Chilean Income tax law

[9] As per inciso 2°, numeral XVIII – section 3 of transitional provisions of law N° 20.780


By Gonzalo Garcia Perez, Senior Wealth Planner – Wealth Structuring Solutions

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